Unit 13 Quiz

Derek's is a brick-and-mortar toy store. The firm is considering expanding its operations to include Internet sales. Which one of the following would be the best firm to use in a pure play approach to analyzing this proposed expansion?

A toy store that sells online only

Boone Brothers remodels homes and replaces windows. Ace Builders constructs new homes. If Boone Brothers considers expanding into new home construction, it should evaluate the expansion project using which one of the following as the required return for the project?

Ace Builders' cost of capital

.Sixx AM Manufacturing has a target debt?equity ratio of 0.40. Its cost of equity is 15 percent, and its cost of debt is 6 percent. If the tax rate is 40 percent, what is the company�s WACC? (Round your answer to 2 decimal places. (e.g., 32.16))

D/E = 0.40 D = 0.40E D/(D+E) = 0.4/1.4 E/(D+E) = 1/1.4 WACC = weighted average of the individual costs = D/(D+E)*cost of debt * (1-t) + E/(D+E)* cost of equity = 0.4/1.4*6%*0.6 + 1/1.4*15% = 1.02857% + 10.7142857% = 11.742855714 or 11.74%

Tim's Tools just issued a dividend of $1.80 per share on its common stock. The company is expected to maintain a constant 4 percent growth rate in its dividends indefinitely. If the stock sells for $31 a share, what is the company's cost of equity? 8.81 percent 9.94 percent 9.37 percent 10.04 percent 10.46 percent

D0 = 1.80 D1 = 1.80 * 1.04 = 1.872 Let cost of equity be r. Then as per DDM, stock price = D1/(r-g) = 1.872/(r-0.04) 31 = 1.872/(r-0.04) r-0.04 = 1.872/31 = 0.0604 r = 0.0604+0.04 = 0.1004 or 10.04%

Which one of the following will decrease the aftertax cost of debt for a firm?

Increase in tax rates

Trendsetters has a cost of equity of 14.6 percent. The market risk premium is 8.4 percent and the risk-free rate is 3.9 percent. The company is acquiring a competitor, which will increase the company's beta to 1.4. What effect, if any, will the acquisition have on the firm's cost of equity capital?

Increase of 1.06 percent 3.9 + 1.4(.084) = 15.6 15.6 - 14.6 = 1.06

Which one of the following is most apt to cause a wise manager to increase a project's cost of capital? Assume the firm is levered.

She learns the project is riskier than previously believed.

Which one of the following is the primary determinant of an investment's cost of capital? Amount of the initial cash outlay The investment's level of risk Life of the investment The investment's net present value The source of funds used for the investment

The investment's level of risk

Smith and Weston has 55,000 shares of common stock outstanding at a price of $31 a share. It also has 3,000 shares of preferred stock outstanding at a price of $62 a share. The firm has 8 percent, 12-year bonds outstanding with a total face value of $400,000. The bonds are currently quoted at 101.2 percent of face and pay interest semiannually. What is the capital structure weight of the firm's preferred stock if the tax rate is 35 percent? 8.10 percent 15.20 percent 15.67 percent 16.84 percent 17.63 percent

Total Market value = (55000*31)+(3000*62)+(400000*1.012) = $2295800 Weight of firms preferred stock = (3000*62)*100/2295800 = 8.10%

Clifford, Inc., has a target debt-equity ratio of .85. Its WACC is 8.4 percent, and the tax rate is 35 percent. a. If the company's cost of equity is 12.5 percent, what is its pretax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Pretax cost of debt % b. If the aftertax cost of debt is 5.1 percent, what is the cost of equity? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Cost of equity %

We need to know that debt equity ratio is just a multiplier. D/E = .80 == D/E = 0.80/1 Or, we can say that D = .80/1.8 and E = 1/1.8. D = 44.4% and E= 55.6% Solving for WAAC, we have = WACC = [Weight of Equity * Cost of equity] + [Weight of debt * Cost of debt (1 � Tax rate)] 0.084 = [0.556 * 0.12] + [0.444 * K (1 � 0.35)] 0.084 = 0.067 + 0.289K Or, K = 5.88% = Cost of pre-tax debt If the after tax cost of debt is 5.1% then cost of equity will be= 0.084 = [0.556 * K] + [0.444 * 0.051] 0.084 = 0.556K + 0.023 K = 10.97% = Cost of equity.

A firm uses its weighted average cost of capital to evaluate the proposed projects for all of its varying divisions. By doing so, the firm:

automatically gives preferential treatment in the allocation of funds to its riskiest division.

Lester lent money to The Corner Store by purchasing bonds issued by the store. The rate of return that he and the other lenders require is referred to as the:

cost of debt.

A firm that uses its weighted average cost of capital as the required return for all of its investments will:

increase the risk level of the firm over time.

In an efficient market, the cost of equity for a highly risky firm:

increases in direct relation to the stock's systematic risk.